Saturday, 2 July 2016

Behavioral economics is relatively new and was found to explain the abnormalities in the decisions made by a person. The success of lottery practice where the probability of losing is much higher than gaining, people exacting revenge even though it inflicted more pain to the person exacting revenge all this were the discrepancies which the classical economic theory couldn't explain. In classical economic theory, a man is considered to be rational and self-interested who make decisions after evaluating the costs and benefits and make a decision by maximizing the profit for themselves.

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Behavioral economics is a fusion of psychology and economics, it draws on the insight of the psychology to understand the decision-making process of people in a better ways. Behavioral economics focuses on psychological,social and emotional factors that influence a person decision-making process. Our decisions depend on the way the alternatives are framed even if these alternatives have the same value. Framing the alternatives differently can change people perception towards risk. People feel more pain of loss as compared to the joy of gain. To test this theory, an experiment was conducted where the employees of a company were divided into 3 groups. For the first group, things were left as usual. For the second group, a bonus was promised provided they meet the specific goals and for the third group, a bonus was given but with a caveat that they had to return this bonus if they didn't meet the goals. At the end of the year, the productivity of the first and the second group was on the similar lines but the productivity of the third group increased drastically. This result was is consonance with the theory.

Today behavioral economics has applicability in various fields such as finance, health, workplace productivity etc. So how does behavioral economics operate? As we know that humans can be quite irrational at times and it's very costly and time-consuming process to teach them to make a good decision. So behavioral economist try to identify the psychological issue underneath a problem and then they design a change in order to manipulate the social and emotional factors thereby increasing the probability of making better decisions. Once the change is designed they form a control group where for some people things are left as usual and for others these changes are implemented. Finally, after some time the results of the implemented change on these control group are compared to understand if the designed change was successful or if it made no difference.